Child Care Expenses: The Child Care Credit: From The Encyclopedia of Taxation and Tax Policy

66Child care expenses: the child care creditChild care expenses: the childcare creditAmy E. DunbarUniversity of IowaA nonrefundable credit based on employment-related expenses of household-type servicesfor the care of children.The Internal Revenue Code provides tax benefits inthe form of a credit or exclusion for child care ex-penses incurred by taxpayers deemed to be gainfullyemployed. The credit was enacted in the Tax Re-form Act of 1976 by repealing Section 214, whichallowed an itemized deduction for child care ex-penses, and replacing it with Section 44A (redesig-nated as Section 21 by the Tax Reform Act of1984). The Section 129 dependent care exclusionfor assistance from employers was enacted by theEconomic Recovery Tax Act of 1981 and subjectedto a $5,000 cap by the Tax Reform Act of 1986.Both the credit and the exclusion are subject toearned income ceilings that limit the qualified childcare expenses in any taxable year to an amount notin excess of the earned income of the employee or,if the employee is married, the lower of the em-ployee’s earned income or the earned income of hisor her spouse. Thus, these benefits generally are notavailable to one-earner couples. (Spouses who arefull-time students or incapable of caring for them-selves are deemed to earn $200 per month for onedependent or spouse being cared for, or $400 permonth for more than one.)From 1976 to 1981, a credit of 20 percent ofqualified child care expenses was allowed, with amaximum credit of $400 for each of the taxpayer’sfirst two dependents. The 20 percent credit was thesame for all taxpayers. In an effort to make thecredit more progressive, Congress enacted a slidingscale credit in 1982, which is 30 percent of qualifiedexpenses for taxpayers with incomes of $10,000 orless. The credit is reduced by 1 percent for each$2,000 or fraction thereof of income above $10,000.For taxpayers with adjusted gross income (AGI)above $28,000, the credit rate is 20 percent. Themaximum credit for a taxable year ranges from $720for a taxpayer whose AGI is $10,000 or less to $480for a taxpayer whose AGI exceeds $28,000. Whenthere is more than one dependent, the maximumcredit ranges from $1,449 to $960. Effective in1989, the Family Support Act of 1988 reduced dol-lar-for-dollar the amount of expenses eligible for thecredit by the amount of expenses excludable fromincome under Section 129.Focus of researchThis entry focuses on the child care credit, examin-ing its impact on the progressivity of the federal in-dividual income tax from 1979 through 1988. (SeeAltshuler and Schwartz 1996, who use a life-cycleapproach to examine the progressivity of the credit,and Gentry and Hagy 1996, who examine the distri-butional effect of both the credit and the exclusion.)The child care tax benefit progressivity issuehas been addressed by Congress several times.The 1976 conversion of a deduction to a credit and the1982 change to a sliding scale credit were intendedto increase the credit’s progressivity. Congress againaddressed the perceived regressivity of the credit inthe Revenue Reconciliation Act of 1989 debates, butno changes to the credit were enacted at that time.Table 1 reports the total child care credit andtotal credits claimed during the 1979–1988 periodon all returns filed as reported by Publication 1304,Individual Income Tax Returns. The child carecredit represents a large portion of the total creditsclaimed, increasing substantially over the sampleperiod. (“Total credits” as reported in Publication1304 do not include the earned income credit thatwas refunded or offset against taxes other than in-come taxes. For example, in 1988, individual tax-payers paid approximately $413 billion in incometax after credits and received $12 billion in credits(including $5 billion of earned income credit), ofwhich $4 billion was child care credit.) This re-search extends Dunbar and Nordhauser’s (1991)progressivity research on the child care credit by(1) using the Kakwani index in addition to the SuitsT A B L E 1 Total Credits Claimed on All Returns and Credits Claimed on Sample Returns(thousands of dollars)1979198019811982198319841985198619871988Child Care 793,143 956,4391,147,9071,501,4532,051,4622,648,834 3,127,7023,397,0903,438,3143,812,849CreditTotal Credits6,780,1867,215,8397,905,2947,854,4938,190,7379,263,30810,248,0447,020,7316,329,4387,047,140Source: Internal Revenue Service. Child care expenses: the child care credit67index, (2) considering the impact of the income dis-tribution on these indices, and (3) adding two years,1987 and 1988, to the sample period. A compar